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The Fraud Watch: January 2011

Microfinance industry crisis

The availability of profitable projects in rural Andhra Pradesh at the market interest rate, on a scale commensurate with current volume of microcredit lending, seems improbable.

The recent microfinance crisis in Andhra Pradesh has exposed a fundamental mismatch between instruments and objectives.

Directed credit such as microfinance, or priority-sector lending — its broader counterpart, is economically justified only if the beneficiary entities use it to finance projects that are profitable at the market rate of interest but have not been discovered by the market. When this condition is satisfied, it is generally observed that the same default rates are application in the case of directed credit as on market-driven credit.

However, high default rates and repeated loan waivers point to the failure of microcredit to satisfy this condition. Indeed, the availability of profitable projects in rural Andhra Pradesh at the market interest rate, on a scale commensurate with the current volume of microcredit lending, seems improbable.

A plausible conclusion is that at least in rural areas, the principal aim of microcredit is not to correct market failure in credit markets.

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